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CVS: The Better Suitor

It's been a soap opera, but the pharmacy chain's proposed merger with Caremark could lead to a prosperous marriage.

By Thomas M. Anderson, Contributing Editor
January 12, 2007

Like a jilted lover, Express Scripts doesn't know when to quit. The pharmacy benefit manager tried to stop rival Caremark Rx from walking down the aisle with drug store chain CVS. It ponied up $26 billion to woo Caremark from the arms of CVS, which offered to pay only $21 billion in November. But Caremark's board of directors rejected Express Scripts' bid on January 7 and chose to stick with its original suitor. That bodes well for shares of CVS, the nation's largest retail drug-store chain.

Undeterred by the rejection, Express Scripts sprung into action. It announced that it would push its own slate of candidates for Caremark's board and asked a Delaware court on January 10 to void a $675 million breakup fee that protects the planned Caremark-CVS marriage.

Caremark shareholder approval is the next major step toward closing the deal. The date of the vote has not been set, but Raymond James analyst John Ransom says it could occur in as early as February. "We continue to believe that CVS will sweeten its current bid for Caremark in order to gain crucial shareholder support," he says.

If these companies were people, the corporate love triangle would make quite a soap opera. For investors, CVS could well emerge the hero in this drama. Ransom rates the stock (symbol CVS) as his best pick for 2007.

Volume matters in the drug business. The combined purchasing power of CVS and Caremark will allow them to negotiate lower prices with drug makers. CVS has said the deal could save the combined company $500 million in the first year after the merger is consummated.

As grooms go, CVS is no slouch. It operates about 6,200 stores in 43 states. The Woonsocket, R.I., company generates more than 70% of its revenue (estimated at $44 billion in 2006) from the pharmacy business. The would-be bride isn't bad either. Caremark is one of the three largest U.S. pharmacy benefit managers, which process prescriptions for corporate and public health plans, and generates more than $33 billion in annual sales.

CVS has been on a buying binge. It absorbed 1,100 Eckerd drug stores that it acquired in 2004. And last year, CVS integrated without a hitch 701 Sav-On and Osco pharmacies it bought from the Albertson's grocery chain. This history gives Ransom confidence that CVS will come through the proposed merger in good shape. The Caremark deal may be a more difficult task since Caremark is a large pharmacy benefit manager rather than a group of drug stores. But CVS is no stranger to the drug benefit management business. It owns pharmacy benefit manager PharmaCare, which generates more than $1.2 billion in annual sales.

The CVS proposal has already cleared a major hurdle: The waiting period has expired for federal regulators to get involved in antitrust actions. That means a shareholder vote would seal the deal. As with any wedding, problems could occur, but Ransom is confident that CVS will win the prize. "CVS is aggressively marketing the longer-term strategic benefits of the transaction," he says. "And, given its recent stock performance, it appears to have gained more support from the market."

CVS shares rose 1.4%, to $31.94, on January 12. Ransom rates the stock a "Strong Buy 1," Raymond James's highest ranking, and has set a 12-month price target price of $40. The stock trades at 17 times the $1.86 a share that Ransom expects the company to earn this year. If CVS ties the knot with Caremark, "the transaction will place the company in a commanding position within the drug channel by late 2007," he says.